Report (Hong Kong)

1

Hong Kong Investment Funds Association

11thAsia Oceania Regional Meeting

1. Industry Statistics

Details on unit trusts and mutual funds authorized by the Securities and Futures Commission (“SFC”) were as follows:

Type of funds / No. of funds / NAV (US$ Million)
Mar 31, 2005 / Mar 31, 2004 / Dec 31, 2004 / Dec 31, 2003
Equity / 884 / 891 / 272,962 / 270,582
Bond / 303 / 294 / 112,486 / 112,048
Money market / 56 / 58 / 94,540 / 81,472
Diversified / 111 / 110 / 38,433 / 41,095
Fund of Funds / 76 / 76 / 4,813 / 3,863
Index / 19 / 22 / 7,362 / 8,139
Guaranteed / 309 / 244 / 18,403 / 15,999
Hedge / 13 / 10 / 1,174 / 405
Other specialized* / 7 / 6 / 1,046 / 685
Sub-total / 1,778 / 1,711 / 551,219 / 534,288
Umbrella structure / 164 / 161
Total / 1,942 / 1,872

* includes futures & options funds and leveraged funds.

Source: SFC

2.Gross Sales by Hong Kong Investors in 2005 (cover data of Hong KongInvestment Funds Association “HKIFA” members only) (Note 1)

In2005, the fund industry registered gross sales of close to US$14,110 million and net sales of about US$1,210 million. Most of the net inflows were registered in the first half of 2005, in particular in the first quarter - US$1,171.61 million of net inflows were registered and accounted for 96.9% of the total net inflows of 2005. The first three quarters of 2005 enjoyed net inflows, but net outflows of US$742.65 million were recorded in the fourth quarter.

Gross sales of equity funds reached US$8,674.82 million, and accounted for 61.5% of the industry total. Gross sales in the second half of 2005 reached US$5,138.60 million, up by 45.3% over that of the first half. On a net basis, net sales of equity funds reached US$1,899.72 million. Most of the net inflows came in the first three quarters.

Bond funds registered gross sales of US$1,859.18 million and net sales of US$ 577.15 million in 2005, representing 13.2% and 47.7% of the industry gross and net total. Most of the inflows into bond funds were recorded in the first half of 2005: about 60% of gross inflows and about 92% of net inflows.

Guaranteed funds registered gross sales of US$1,303.72 million in 2005, accounting for 9.2% of the industry total. About 91% of the gross inflows were registered in the first half of 2005. Net outflows of US$1,157.53 million were recorded in the year and about 95% were recorded in the second half of the year.

3.Selling and Marketing offshore funds

Offshore funds can be marketed to the public in Hong Kong as long as they obtain authorization from the SFC.

For schemes that are domiciled in recognised jurisdictions, they can be approved on “fast track”. Jurisdictions are recognised on the SFC’s understanding that the types of schemes referred to are governed by laws and regulations which are comparable to the SFC Code of Unit Trusts and Mutual Funds or offer equivalent investor protection.

Applications for recognised jurisdictions will generally be reviewed on the basis that the scheme’s structural and operational requirements, and core investment restrictions (except where noted), already comply in substance with the SFC Code of Unit Trusts and Mutual Funds.

The SFC expects recognised jurisdiction schemes to comply in all material respects with the Code and reserves the right to require such compliance as a condition of authorization.

As at the end of March 2005, about 5% of the funds authorized by the SFC were incorporated in Hong Kong. Most funds were domiciled in offshore jurisdictions such as Luxembourg and Ireland. Origin/Net Asset Value of Authorized Funds was as follows:

Number / % / NAV (US$ Million) / %
Hong Kong / 101 / 5.2 / 8,355.4 / 1.5
Luxembourg / 890 / 45.8 / 361.825.3 / 65.6
Ireland / 371 / 19.1 / 110,225.0 / 20.0
Guernsey / 36 / 1.9 / 2,843.5 / 0.5
United Kingdom / 48 / 2.5 / 30,448.2 / 5.5
Other Europe / 8 / 0.4 / 6,481.8 / 1.2
Bermuda / 32 / 1.6 / 2,732.8 / 0.5
BritishVirginIsland / 26 / 1.3 / 1,928.6 / 0.4
Cayman Islands / 421 / 21.7 / 24,933.6 / 4.5
Others / 9 / 0.5 / 1,445.1 / 0.3
Total / 1,942 / 100 / 551,219.3 / 100

Source: SFC. Number of funds: as at the end of March 2005. Asset size: as at the end of December 2004 (excluding “umbrella funds”).

4.Legal and regulatory developments

(a)Recent development:

In April 2005, the SFC revised the Code on Unit Trusts and Mutual Funds to allow SFC-authorised schemes to invest in Investments in Real Estate Investment Trusts (REITs) that were listed on a stock exchange. This helps to broaden the investment choice of SFC-authorised schemes.

In June 2005, the SFC revised the Code on REITs to relax the geographical restriction and to regulate all SFC-authorised REITs under the Code on REITs. Major points covered include:

the geographical restrictions on overseas investments were lifted so that REITs might invest in real estate anywhere in the world;

the experience in managing property portfolio investments was recognised as a core competence for the purpose of assessing the qualification of a REIT management company;

gearing ratio was raised to 45% of gross asset value of a REIT;

additional layers of special purpose vehicles might be considered in special circumstances;

proposals to take out professional indemnity insurance and title insurance were removed; and

special product features might be considered by the SFC on a case-by-case basis – e.g. payment of management fees by way of units.

In July 2005, after two rounds of consultation with the industry in 2004 and 2005, the Revenue (Profits Tax Exemption for Offshore Funds) Bill 2005 was tabled for debate at the LegCo. The Bill was passed by the LegCo in March 2006.

In September 2005, the SFC published the consultation conclusions on Proposed Amendments to Schedule 5 to the SFO. The proposed amendments included:

extending the definition of “asset management” to include management of real estate investment trusts;

amending the definition of “dealing in securities” to exclude dealings by approved money brokers where they represented authorised financial institutions; and

amending the definitions of “advising on securities” and “advising on futures contracts” to exclude licensed asset managers where they gave advice on their own funds.

The amendments have become effective in January 2006.

In September 2005, the SFC revised the Hedge Fund Guidelines contained in Chapter 8.7 of the Code on Unit Trusts and Mutual Funds. Three main areas of the revised guidelines were:

to adopt a holistic approach in the assessment of a management company, and providing greater flexibility in recognising the experience of fund manager’s key personnel;

to increase the transparency of the management company’s operations through additional disclosures in the offering documents of its risk monitoring and due diligence process; and

to consolidate and codify existing SFC regulatory practices in the application of Hedge Fund Guidelines by way of additional notes.

Also, the SFC decided that:

the minimum subscription threshold for SFC-authorised single hedge funds would be maintained at US$50,000; and

there would not be a relaxation of the current restriction imposed on the level of collateralisation to prime brokers for SFC-authorised hedge funds.

In October 2005, the SFC published the consultation conclusions on the Proposed Revised Prevention ofMoney Laundering and TerroristFinancing Guidance Note. The revised Guidance Note sought to:

bring the SFC’s requirements on prevention of money laundering and terrorist financing on a par with the latest standards and principles set by the Financial Action Task Force on Money Laundering and the International Organization of Securities Commissions; and

build in a fair degree of flexibility to allow firms to implement the provisions on a risk-sensitive basis. This was achieved by adopting a principle-based approach (rather than a prescriptive one) and giving guidance on areas where clarification of issues concerning the practical application of the Guidance Note was necessary.

The Guidance Note has become effective in April 2006.

In November 2005, the HKSAR Legislative Council (LegCo) passed the Revenue (Abolition of Estate Duty) Bill 2005 which amended the Estate Duty Ordinance to abolish estate duty. The Ordinance commenced operation in February 2006.

In December 2005, the SFC announced its policy to require that provisions substantially equivalent to those in Part XV (Disclosure of Interests) of the Securities and Futures Ordinance be adopted in trust deeds of REITs. As a result, holders of REIT units were required to submit to the relevant REIT manager and the Stock Exchange of Hong Kong Limited (SEHK) notifications of interests upon the attainment of the 5% disclosure threshold and other changes thereto in accordance with the provisions of the relevant trust deed. In order to enhance transparency of and public access to information regarding interests in REIT units, such notifications received by SEHK would be posted on its website, in the same manner as the disclosure of interests in shares of listed companies.

(b)Recent survey:

In July 2005, the SFC released the findings of its Fund Management Activities Survey (FMAS) 2004. The FMAS has been conducted by the SFC on an annual basis since 1999 to collect information and data on the general state of affairs of the fund management industry in Hong Kong. The survey covers the fund management activities of two types of firms in Hong Kong, namely:

corporations which are licensed by the SFC and engage in asset management and fund advisory businesses (collectively “licensed corporations”); and

banks which engage in asset management and other private banking activities (collectively referred to as “registered institutions”), and are subject to the same regulatory regime (i.e. the Securities and Futures Ordinance) as the licensed corporations in respect of their fund management activities.

Key findings of this survey included:

Combined fund management business of licensed corporations and registered institutions amounted to HK$3,618 billion at the end of 2004, up from HK$2,947 billion in 2003 (23% year-on-year growth in value);

HK$2,269 billion, or 63% of the combined fund management business, was sourced from overseas investors (2003: 63% sourced from overseas);

SFC licensed corporations accounted for 80% or HK$2,896 billion of the combined fund management business, the remaining 20% or HK$722 billion was reported by registered institutions; and

53% of the assets under management were managed onshore.

(c)Other comments and outlook:

The SFC continues to monitor the latest developments in the Undertakings for Collective Investment in Transferable Securities (UCITS) III, the regulations issued by the European Union Commission that govern funds domiciled in the EU states, and maintain dialogue with overseas regulators and market practitioners. As at the end of December 2005, the SFC had authorised 1,016 UCITS III funds, representing over 88% of the applications applied.

5.Distribution channels of authorized funds in Hong Kong

(a)Distribution channels:

In Hong Kong, authorised unit trusts and mutual funds are distributed through various distribution channels, namely:

Direct: fund houses – their investment centres;

Intermediaries: private and retail banks, independent investment advisers, discount brokers; and

Others: accounting firms and insurance companies.

(b)Trends:

Banks (especially retail banks) continue to be the most popular channel of funds distribution.

The significance of insurance companies in fund distribution is also growing as more and more investment-linked saving/insurance plans are being offered for long-term investment.

6.Fee structures and licensing of intermediaries

(a)Types and average levels of fees:

Type of fees

Type
of Funds / Initial
Charge / Annual management fee / Redemption charges/
Performance fee
Money Market / 0%-2% / 0.25%-1% / Varies: the more
sophisticated the
instrument, the higher the fee.
Bond / 3%-5% / 0.5%-1.5%
Equity / 5%-6% / 1%-2%
Warrants / 5%-7% / 1.5%-2.5%
Notes: / Included in the offer price / Accrued on a daily basis. Will not constitute as an out-of-pocket expense.

(b)Cap on fees: No statutory restriction on the level of fees and charges, as they are determined by market forces. Nevertheless, the level/basis of calculation of all costs and charges payable must be clearly stated.

(c)To tie in with the licensing regime, the Hong Kong Securities Institute (“HKSI”) has launched the Licensing Examination for Securities and Futures Intermediaries since June 2003. Candidates have to take different regulatory papers – depending on the types of activities in which they are engaged.

7.Valuation

Virtually all authorized unit trusts/mutual funds use the forward pricing method for valuation purposes.

All funds must be valued and priced in accordance with the provisions of their offering and constitutive documents and the provisions of the SFC Code on Unit Trusts and Mutual Funds.

8.Pricing Errors

The SFC Code on Unit Trusts and Mutual Funds specifies guidelines regarding reporting requirements and compensation to investors in case of pricing errors:

In any case of a pricing error on units/shares, the error should be corrected ASAP and any necessary action should be taken to avoid further error.

If the error results in an incorrect price of 0.5% or more of scheme’s net asset value per unit/share, the trustee/custodian and the SFC must be informed immediately.

In case of pricing error, where total loss to individual investors (either purchasing or redeeming) is more than HK$100 or such lesser amount as the management company may decide, investors should be compensated in such manner as the management company should determine with the approval of the trustee/custodian.

9.Internal Control and Systems of Trustee/Custodian

The Guidelines for Review of Internal Controls and System of Trustees/Custodian of the SFC Code on Unit Trusts and Mutual Funds set out minimum best practice on internal control which will be acceptable to the SFC:

The internal control review should involve all material procedural and control elements relevant and necessary to the responsibilities of trustee/custodians in relation to scheme. The review should be conducted in accordance with generally acceptable international auditing practices.

The engagement letter between the trustee/custodian and the auditor should incorporate or refer to the Terms of Reference which sets out, as a minimum, the scope of review for compliance with the requirements of the Code.

The management of the trustee/custodian must issue a report to describe the control objectives.

The auditor should issue a report, addressed to the management of the trustee/custodian, detailing the scope of the review work carried out relating to the report by management and the conclusions reached.

The auditor should state his opinion on:

whether the accompanying report by the management of the trustee/custodian describes fairly the control procedures in place during the period under review; and

whether the specific control procedures tested (with details described) operated as described during the period under review.

The review of internal controls and systems of trustee/custodians of scheme should be conducted on an annual basis. The SFC reserves the right to demand more frequent review of a trustee or custodian should this be deemed necessary.

10.Performance Evaluation

The Advertising Guidelines of the SFC Code on Unit Trusts and Mutual Funds stipulate that:

All advertisements using performance data, including charts, graphs and tables, should use either the first or last business day of each month or the first or last dealing day of the fund as the reference date, which in any case should not be arbitrary. The computation basis should also be stated, e.g. offer-to-offer or NAV-to-NAV.

All performance data (including awards and rankings) should be referenced to the source and dated, and supporting documents should be submitted to substantiate the data or the calculation.

Performance data should be up to date and no more than 6 months old except for print media advertisements, which should be no more than 2 months old. In either case data should be updated if more recent data are significantly different.

Performance data must be actual rather than simulated results. Annualized returns are generally only acceptable if the actual returns for all the individual years are also shown.

A comparison of performance figures should be fair, accurate and relevant, comparing “like with like”.

If non-US$/HK$ denominated returns are shown, the advertisement should also show the returns in US$/HK$ terms. If performance is quoted in another currency for comparison with other funds, the performance in the scheme’s base currency should be given as well.

There are a number of independent vendors tracking fund performance, namely, Standard & Poor’s Fund Services, Lipper Asia, and Morningstar Asia Limited.

11.Development of the pension systems

(a)Data on MPF as at December 31, 2005:

Number
Constituent Funds / 332
Enrollment Rate
Employers
Employees
Self-employed persons / 98.2
97.4
77.6
Total assets as at December 31, 2005* / HK$151.36 billion

* including assets transferred from the ORSO schemes

Source: Mandatory Provident Fund Schemes Authority (“MPFA”)

(b)Recent regulatory development:

In March 2005, the MPFA recognised the industry performance presentation standards submitted jointly by the Hong Kong Investment Funds Association and the Trustees Association for the purposes of the Code on Disclosure for MPF Investment Funds. The effective date of the Standards was July 1, 2005. Fund fact sheets sent by approved trustees on or after that date should comply with the requirements of the standards. The standards were developed to specify the methods that approved trustees should use in preparing, calculating and presenting the information required as minimum content in a fund fact sheet. They covered fund performance information, fund risk indicators and fund descriptor as set out in the Disclosure Code.

In July 2005, the MPFA released the Compliance Standards for approved MPF trustees to assist them in establishing a rigorous framework for monitoring their compliance with statutory duties and responsibilities. The Compliance Standards reflected internationally recognized compliance methodology. There were a total of eight Standards, each accompanied by detailed explanatory notes and examples to provide further guidance to the trustees.

12.Managing funds for Insurance and Pensions

(a)Investment-linked Assurance Schemes (ILASs)

ILASs are long-term investments provided through an insurance policy. These plans usually invest in funds either managed by the insurance company itself, or by other independent fund managers.

ILASs are required to comply with the provisions set out in the Code on Investment-linked Assurance Schemes in order to be authorized by the SFC.

As at the end of December 2005, there were 194 ILASs authorized by the SFC.

(b)Pooled retirement funds (PRFs)

PRFs are pooling agreements for voluntary retirement schemes registered under the Occupational Retirement Schemes Ordinance. As at the end of December 2005, there were 37 PRFs authorized by SFC.

13.HKIFA

HKIFA is a professional body that represents the fund management industry of Hong Kong.

Established in 1986, HKIFA has two major roles, namely the promotion of Hong Kong managed investment products and consultation with the appropriate authorities to relay the views of its members on issues that have implications for the fund management industry. Its objective is to enable Hong Kong people to understand more about the characteristics of mutual funds; and to use them effectively for retirement investment and other financial planning purposes.